Sunday, November 03, 2013

The consensus seems to be that the FOMC will wait until 2014 to start to taper QE purchases. As an example, from Michael Hanson at Merrill Lynch:

The thresholds to taper are not as high as some think, but we see a relatively low chance that the data will be strong enough to allow tapering in time for the holidays.
...
[T]he Fed needs to see the economy move toward the “tolerable twos” to taper: growth in the upper-2% range, closer to job gains of 200,000 per month, and inflation converging (even if slowly) toward the 2% target. That is a heavy burden by the December meeting, but if the post-shutdown data rebound, January remains possible — as do the next several meetings afterwards. And as we have said before, time will tell.

And analysts at Nomura have put the odds of a "taper" in December at just 15%, and they view March 2014 as the most likely meeting for the FOMC to start reducing asset purchases.

Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.

Although not mentioned in the FOMC statement, at the September press conference Fed Chairman Ben Bernanke suggested that one of the reasons the Fed didn't taper was that they wanted to see the results of the budget negotiations. Now those "negotiations" are behinds us (for now), and although the government shutdown was expensive and dumb, at least there wasn't any additional fiscal restraint added.

Here is what I think it would take to taper at the meeting of December 17th and 18th.

1) The unemployment rate probably increased sharply in October (due to the shutdown), but the impact of the shutdown will be reversed in the November report that will be released on Friday December 6th. If the unemployment rate declines back to 7.2% or so in November (the September rate), then the FOMC might taper.

2) As Merrill's Hanson noted, the FOMC would probably also be looking to see employment growth close to 200,000 in the November report. If the year-over-year change in employment is still around 2.2 million for November, the FOMC might taper.

The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.

The PCE price index for October will be released on December 5th (the September PCE index will be released this week). If PCE prices are moving back towards 2%, the FOMC might taper. Note: CPI for November will be released on December 17th and might influence the decision.

4) On fiscal policy, the budget conference committee is scheduled to present an agreement on December 13th (just before the FOMC meeting). The committee is expected to play "small ball", so it is possible an agreement will be reached. If a reasonable agreement is reached (hopefully reduce the impact of the sequester in 2014), then the FOMC might be more inclined to taper. If it appears that the House might shutdown the government again, the FOMC will be inclined to wait.

There are many key releases right at the beginning of December, and we know the Fed is "data dependent". So here is what the FOMC would like to see to start tapering: 1) the unemployment rate fall to 7.2% in the November report, 2) Employment up about 2.2 million year-over-year in November, 3) inflation increasing toward 2% target, and 4) some sort of fiscal agreement by Dec 13th. All possible.